On May 11, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the 2015 Article IV consultation with Luxembourg.¹

Luxembourg’s economic model, emphasizing fiscal stability, openness, firm prudential oversight, and responsiveness to investor needs, is delivering strong growth. Buoyant financial services exports contributed to real growth of close to 3 percent in 2014, with strong job creation. Growth is projected at 2½ percent this year, bolstered by the ECB’s quantitative easing.

Budget 2015 launched a multi-year fiscal consolidation aimed at offsetting falling revenues from electronic commerce. Faced with a projected reduction in these revenues by up to 1.3 percent of GDP this year, the budget targets a broadly balanced general government position in 2015, and moderate surpluses in 2016–18.

The economy faces important challenges going forward. Evolving international tax transparency standards, in which Luxembourg is participating fully, could impact the revenue base. Financial sector complexity occasionally tests oversight arrangements, where maintaining a strong regulatory and supervisory reputation is central to attracting international business. Finally, population aging will give rise to significant spending pressures over the long term, necessitating further reforms to the pension system.

Executive Board Assessment²

The Executive Directors commended Luxembourg’s continued strong macroeconomic performance underpinned by fiscal prudence and sound institutions. Directors noted that the main policy challenge ahead is to strengthen an economic model that has served the country well but will be tested by changing international financial regulations and tax regimes. Continued further fiscal and structural reforms to diversify the economy and lift youth and women’s employment are needed to support growth prospects.

Directors noted that the current budget and medium-term fiscal plan appropriately address falling value-added tax revenues from electronic commerce. They also supported the authorities’ goal to maintain budget surpluses over the medium term. In this regard, Directors agreed that deeper reforms are needed to ensure that the pension system is resilient to population aging. They welcomed the decision to bring forward by one year a review of the impact of earlier reforms. Directors also welcomed the creation of the new sovereign wealth fund, and saw merit in boosting its funding with future windfall receipts, including from divestment proceeds.

Directors welcomed Luxembourg’s continued participation in EU and OECD/G20 tax transparency initiatives. They encouraged the authorities to assess the impact of any tax base erosion at home and to develop options for diversifying revenue sources. Directors also pointed to the need to seek further expenditure savings based on expenditure reviews.

Directors encouraged the authorities to fully adopt legislation related to the EU banking union in order to maximize the benefits of Luxembourg’s participation. They took note of the recent passage of the law to establish a systemic risk committee with an appropriately broad remit which will contribute to further strengthening of the financial sector. Directors also recommended reviewing the oversight of nonbank holding companies that control banks as well as their nonbank subsidiaries. In this regard, they welcomed the authorities’ intention to advocate for strong arrangements at the EU level while exploring the limited options Luxembourg could take using national discretion given the harmonized EU rules.

Directors agreed that structural reforms to diversify the economy beyond the financial sector are helpful to improve Luxembourg’s long-term growth. They welcomed the authorities’ efforts to further enhance the business climate and raise youth and women’s participation in the labor force. Directors also recommended additional active labor market policies, including more effective training programs, as well as reforms to reduce skills mismatches and boost incentives to work. A number of Directors noted that adjusting the wage indexation mechanism could help preserve the competitiveness of Luxembourg’s economy.